Question

“The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer.

Short answer

The statement is correct. The lender can avoid the problem of asymmetric information by making loans backed by more collateral securities.

Step-by-step solution

Content Introduction

Loan backing with collateral refers to a secured loan that is secured against collateral security. Asymmetric information refers to the problem where both parties do not have the same information.

Content Explanation

A collateral is an asset that is used as a security to back a loan. If the borrower defaults, they are at risk of losing the collateral. When more collateral is used to back a loan it would be riskier for the borrower to default. So, they are more likely to behave in favor of the lender.